CHAP 5: PRICING, ADVERTISING AND INVESTMENT POLICIES IN BUSINESS

5.1. BASIC PRICING STRATEGIES

PERFECT COMPETITION
Short-run Output Decision
● AVC tells whether to produce: Shut down if price falls below minimum AVC: P<AVC
● SMC tells how much to produce: If P minimum AVC, produce output at which P = SMC

● ATC tells how much profit/loss if produce

● Determine the quantity to maximize profit - SMC intercept with D: SMC = D

Exercise 1:
From a consulting firm, Aztec predicted consumer income and price of signal tuning tool in 2002
are $45.000 and $800, respectively.
Aztec estimated their average variable cost function: AVC = 28 - 0,005Q + 0,000001Q2
1. What is Aztec’s optimal decision in 2005, knowing that their estimated fixed cost is
$270.000?
2. What is Aztec’s decision when the demand function changes as a result of reduced
consumer income? P = 80 – 0,002Q
Summary:
Q = 41.000 - 500P + 0,6M - 22,5Pr
AVC = 28 - 0,005Q + 0,000001Q2
P = 80 – 0,002Q
M2002 = $45.000 ; P2002 = $800
Estimated fixed cost = $270.000
Answer:
Q = 41.000 – 500*P + 0.6*45.000 – 22,5*800
=> Q = 50.000 – 500P
=> P = 100 – 0.002Q
TR = P*Q = 100Q – 0.002Q^2
MR = TR’ = 100 – 1/250*Q = 100 – 0.004Q
MC = TC’28 – 0.001Q + 0.0000003Q^2
Replace Q = 6000 into demand function => P = 88

Monopoly & Monopolistic Competition

Cournot Oligopoly
Exercise:
Homogeneous product Cournot industry, 3 firms.
MC = $10.
Elasticity of market demand = - 1/2.
Determine the profit-maximizing price?
Answer:
Ef = N*Em = -1.5
P = (Ef/(1+Ef))*MC = (-1.5/(1-1.5))*10 = 30

5.2. STRATEGIC PRICING FOR GREATER PROFITS

Price Discrimination
Two-part pricing
Block Pricing
Commodity Bundling
5.3. PRICING STRATEGIES FOR SPECIAL COST AND DEMAND STRUCTURES
Peak-Load Pricing
Cross -Subsidies
5.4. ADVERTISING POLICIES
5.5. INVESTMENT POLICIES